A trade is completed with a buy and sell order. This means, if a trade is entered by buying stocks of a company, then it will be exited by selling those stocks. Similarly if its entered by selling shares of a company, then the trade will be completed by buying shares. We have a number of trading order types for buying and selling shares in the capital market. Before discussing those trading order types, let’s discuss how buying and selling instructions are executed in the stock market.
Execution process in stock market
When you place a buy or sell request, it automatically goes into a processing system in which these are processed based on certain set of rules.
All pending requests in stock market gets arranged by the quoted price. The best ask price sits on the top of the list and the lowest bid price placed at the bottom of the list.
As order comes in, they are filled at these best prices on first in first out basis based on the available prices.
When you place a market buy order, you receive your stock at the highest price on the market at that particular time of execution. When you place a market sell order, you receive the lowest price on the market. If you want to control the execution price, then go for limit order. These terms may sound complicated to you at the beginning but in reality they are simple concepts to understand the trading strategies. You can use it to set your price for buying or selling stocks.
In limit order, you set the maximum value per share you are willing to pay or minimum value per share you are willing to accept for buying or selling a stock, respectively. As you have set a specific price (limit) to buy or sell your stock, there is no guarantee that it will get executed. If market reach your quoted value and you get a buyer, then only it gets executed.
Limit orders are executed first in first out (FIFO) basis. This means its processed as they are received. First request will always be processed first. It may happen that the stock has reached the buying price you have set but again fluctuate above your limit before it gets executed.
In case of sudden drop in price, there are chances that your stock gets executed at your price. But in such cases, you may be sitting on a loss based on the fall in prices below your buying price. Therefore, you need to take extra caution while placing a limit order. For example, suppose you want to buy shares of XYZ limit which is trading at a value of Rs 250 per share. To buy shares, you have placed a limit of Rs 240 per share. Suddenly the CEO of the company resigned and due to this uncertainty, the stock value falls to Rs 220. In such a case, your buying request gets executed with a loss of Rs 20 per share as you had a chance to buy the stock at a better value of Rs 220 per share.
Out of all the trading order types, market order is the simplest and most common type of share trading. In it you tell the broker that to get a particular stock of a company, you are willing to pay whatever price presented by the market. These types of trading strategies are easy to execute but doesn’t guarantee the price.
For instance, when you place a market buy order, market consider it as you want to buy the shares regardless of the price.
In a highly volatile market if the price is moving against you, you can place a market order to get out of the situation. This strategy will best suit for a stock which is trading in a narrow range. You can also use it if buying or selling a particular stock needs to happen quickly with less importance to price.
Stop orders are generally used to lock in profit from a profitable trade. Here is how it works.
Suppose you own 100 shares of XYZ limited at Rs 100 per share. Present market value of the stock is Rs 125 per share. Now you don’t want to sell it, but to cover your profit from falling market value of XYZ limited, you can place a stop order at a price between Rs 125 and Rs 100 per share. Suppose, you have set the price at Rs 120 per share. In this case, if the share value of XYZ limited falls to reach Rs 120 per share, your stop order automatically converts to a market order. At this point, ordinary rule of the market applies and your request get processed by the broker. It’s basically designed to limit an investor’s loss on a position in a security.
If you as an investor holds 100 shares of ABC limited at Rs 25 per share wants to sell it at a value higher than the present market value of Rs 32, then to protect your profit, you can place a stop order at Rs 30. By doing so, you will be holding the stock as long as the value per share does not reach Rs 30.
In selling short strategy, you take advantage of a stock when its grossly overvalued. Lets understand this strategy with the help of an example. Suppose stocks of XYZ limited is grossly overvalued and you are expecting the stock to fall. In such a case, you can enter into a short sell order by borrowing shares of XYZ limited from your broker and selling them at the open market to collect cash. Suppose, as per your expectations, stock value of XYZ limited falls. In this case you can buy shares of XYZ limited and return then to the broker to settle your dues. The difference between your selling price and buying price after taking out broker’s commission is profit for you.
Please note, to execute short selling you need to have a margin account with the broker.
Above four trading order types are more frequently executed in the capital market to get the best price for buying or selling stocks. If you have any doubts, please use our comment section below to ask us questions.